(A version of this article originally appeared in the September 2006 issue of Bench & Bar magazine.)
From the Cardiff Man to Enron, fraud has always been part of the human condition, and it finds increasing notoriety in today’s headlines. Common law fraud crops up in disputes of all kinds and is therefore a critical tool of the general litigator. Yet few law schools teach a specific course on fraud, and few commentators have written on the topic in Minnesota. This article summarizes some key points for any practicing litigator in the state.
There are many types of fraud – insurance fraud, welfare fraud, election fraud, healthcare fraud, securities fraud, bank fraud, immigration fraud, consumer fraud, internet fraud, patent fraud, accounting fraud, tax fraud, and mail fraud – to name a few. But for the most part, all fraud-type claims have similar elements. Recently much attention has been paid to the expansion of various consumer fraud statues in Minnesota, which are outside the scope of this article. The litigator should certainly be familiar with these statutes (which allow claims for attorney’s fees), but in order to understand these laws and how they alter the common law, it is helpful to review the history of basic fraud, which is often pled alongside statutory claims.
From the Latin fraus meaning “deceit,” fraud has ancient roots as the independent tort of deceit, but it has been and continues to be closely intertwined with contract law as well. According to Professor Prosser, there was an old writ of deceit known in England as early as 1201, but tort and contract law were not clearly distinguished at that time. Young B. Smith & William L. Prosser, Cases and Materials on Torts (2d ed. 1957). Building upon these English origins, fraud has been recognized as a tort at common law in Minnesota since the 1800s. See, e.g., Lynch v. Mercantile Trust Co., 18 F. 486 (C.C.D. Minn. 1883).
“Fraud” and “Misrepresentation”
The difference between fraud and misrepresentation is that not all misrepresentations are fraud, but almost all fraud involves a misrepresentation. Fraud is an intentional misrepresentation, and thus is requires an element of intent, also known as scienter. Various courts have referred to this claim as “fraud,” “intentional misrepresentation,” or “deceit.” Minnesota courts use the terms “interchangeably.” Michael K. Steenson & Peter B. Knapp, Minnesota Jury Instruction Guides, Minnesota Practice Series, at 446 (4th ed. 2002). Negligent misrepresentation, on the other hand, can occur without intent to deceive and is therefore technically not fraud. To add to the confusion, some courts use the term “fraud” to denote a general category of misrepresentation claims. See e.g., Williams v. Tweed, 520 N.W.2d 515, 517 (Minn. Ct. App. 1994) (finding “Three types of misrepresentations fall under [the] broad category of fraud: reckless misrepresentation, negligent misrepresentation, and deceit”).
In a complaint or counterclaim, therefore, fraud might be pled alternatively as “fraud,” “deceit,” “common law fraud,” “misrepresentation,” “intentional misrepresentation,” “fraudulent misrepresentation,” or “fraud and misrepresentation.” Collusion is a term that sometimes arises in cases involving fraudulent conduct and is defined by Black’s as “an agreement between two or more persons to defraud a person.”
Elements of Fraud
Then-Eighth Circuit Court Judge and later U.S. Supreme Court Justice Harry Blackmun was the first jurist to articulate the 11-part test for fraud in Minnesota in Hanson v. Ford Motor Co., 278 F.2d 586 (8th Cir. 1960). The elements of common law fraud in Minnesota as he set them out are as follows:
- There must be a representation;
- that was false;
- having to do with a past or present fact,
- that is material;
- and susceptible to knowledge;
- and the representor knows it to be false or asserted the fact without knowledge of whether is was true;
- with the intent to induce the other person to act;
- and the other person was induced to act;
- in reliance on the representation;
- and the victim suffered damages
- attributable to the misrepresentation.
The same 11-part fraud test has been reduced to five elements by several Minnesota courts, as well as by the model jury instructions. Minnesota Jury Instruction Guides, supra note 5, at 447-448 (citing inter alia, Specialized Tours, Inc. v. Hagen, 392 N.W.2d 520, 532 (Minn. 1986)). The five-part test is defined as follows: there must have been:
- A false misrepresentation of a past or present material fact;
- knowledge by the person making the false assertion that it is false or ignorance of the truth of the assertion;
- an intention to induce the claimant to act or to justify the claimant to act;
- the claimant must have been induced to act or justified in acting in reliance on the representation; and
- the claimant must suffer damage proximately caused by the misrepresentation.
Martens v. Minnesota Mining & Mfg. Co., 616 N.W.2d 732, 747 (Minn. 2000). See also U.S. Bank N.A. v. Cold Spring Granite Company, 802 N.W.2d 363 (Minn. 2011) (holding that the term “fraud” as used in Minn. Stat. 302A.423 means “common law fraud” as set forth in Martens.) Plaintiffs may favor the five-part test while defendants may prefer to apply the 11-part test, but the essential elements are the same.
Even if a party thinks that a statement is false at the time it is offered with the intention that it be relied on to the detriment of another, if the representation in fact turns out to be true, and therefore there is no damage to the relying party, then there can be no cause of action for fraud. In other words, as with defamation, truth can be defense.
A fraud claim cannot properly be based on a misrepresentation that is contingent on a future event, even if the representation was knowingly false at the time it was made. Schoenhals v. Mains, 504 N.W.2d 233, 236 (Minn. Ct. App. 1993) (fraud action not sustained where church members were promised profits of the future sale of the church; their proof that the pastor never intended to share profits with them was irrelevant because the church had not yet been sold). Vague or indefinite statements such as “I’ll look into it,” or “I’m working on it” provided by management in response to an employee’s request for severance benefits have been held not to support a misrepresentation claim because the words are not specific enough to include an actual representation of fact. Swedeen v. Swedeen, 134 N.W.2d 871, 875 (Minn. 1965); Martens, 616 N.W.2d at 747.
In the context of product guarantees, statements such as “years of trouble-free performance” have been determined to be too “vague and abstract” to constitute a misrepresentation. Chase Resorts, Inc. v. Johns-Manville Corp., 476 F. Supp. 633, 639 (E.D. Mo. 1979), aff’d 620 F.2d 203 (8th Cir. 1980). Similarly, in a dispute involving customer software a court held that statements that the software was “virtually complete,” that it would be available by a certain date, and that is “would be as reliable, stable, and fully functional as” is predecessor software, were “representations of future events rather than statements of past or present fact” and therefore could not, as a matter of law, support fraud claims. Taylor Investment Corp. v. Weil, 169 F. Supp. 2d 1046 (D. Minn. 2001). Facts which are fraudulently misrepresented or omitted must be “material” in order to support a claim for fraud. Whether a misrepresentation is material often depends upon whether a party relies on it or believes it to be important. Berryman v. Riegert, 175 N.W.2d 438 (Minn. 1970).
Defendants may want to characterize statements or alleged representations as “puffing,” which has been widely held not constitute a basis for misrepresentation claim. In re Minnesota Breast Implant Litigation, 36 F. Supp. 2d 863, 879 (D. Minn. 1998) (in a press release regarding its sale of a division to a new owner, 3M’s statement that the “new owners have the ability to continue 3M’s strong quality orientation and service support to the new business” was considered “puffing” and therefore not a fraudulent misrepresentation). See also In re Metris Companies, Inc. Securities Litigation, 428 F. Supp. 2d 1004, 1010 (D. Minn. 2006) (“statements such as, ‘business is on a much stronger profitability track than it has ever been,’ and ‘we have built a fundamentally sound business that is clearly poised for continued profitability,’ …are mere puffery” and cannot sustain a claim for securities fraud).
There are exceptions to the “puffing” argument, however. One court concluded that some statements of opinion, that may be categorized as “puffing” from a “used car salesman,” may be considered statements of fact, and therefore actionable, when emanating from a pharmaceutical salesman because public policy requires a stricter standard for those who sell pharmaceutical and presumably other products which are meant “to be inserted into the human body.” Kociemba v. G.D. Searle & Co., 707 F. Supp. 1517, 1525 (D. Minn. 1989) (noting “that there are strong policy reasons against broadly applying the ‘puffing’ and ‘dealer’s talk’ line of reasoning to a pharmaceutical produce to be inserted into the human body”).
Some key buzz words to be on the lookout for when evaluating a fraud claim include: opinion, estimate, appraisal, prediction, prophecy, expectation, intent or intention, promise, projection, readiness, capacity, capability, will, may, could, might, ought, should, future, and hope. Most of these concepts have been held by the courts as not sufficient to sustain a fraud claim. See 22 Dunnel’s Minnesota Digest Fraud § 2.00(b).
Statements of Law
Statements of law have also been held to be improper as the basis of a fraud claim, as “the law is presumed to be equally within the the [sic] knowledge of both parties.” Miller v. Osterlund, 191 N.W. 919, 919 (1923). However, “an attorney who makes affirmative misrepresentations to an adversary may be liable for fraud.” L & H Airco, Inc. v. Rapistan Corp., 446 N.W.2d 372, 380 (Minn. 1989).
A person who, through his or her profession, business, or employment, or in any transaction in which he or she has a pecuniary interest, fails to exercise reasonable care or competence in obtaining or communicating information, and thereby supplies false information while guiding others in their business transactions, is liable for any pecuniary loss cause by the claimant’s justifiable reliance on the information. Restatement of Torts (Second) § 552 (1979). This is known as negligent misrepresentation.
Florenzano v. Olson, 387 N.W.2d 168 (Minn. 1986), and M.H. v. Caritas Family Servs., 488 N.W.2d 282 (Minn. 1992), are probably the two most often cited cases in Minnesota on the definition of both common law fraud and negligent misrepresentation. In both cases, only the negligent misrepresentation claim survived.
In Florenzano, an insurance agent hired by Ms. Florenzano advised her that she would be a “fool” not to take the “once-in-a-lifetime” opportunity to withdraw from the social security program because she would still receive coverage under her husband’s social security benefits. Ms. Florenzano relied on this advice and withdrew from the social security system. She subsequently became totally disabled due to multiple sclerosis. However, because she had followed the insurance agent’s advice and withdrawn from the program, neither she nor her two children were eligible for social security disability or dependent benefits. Had she continued to participate in the social security system, she and her children would have been eligible for those benefits. The insurance agent conceded that he did not research or verify the information. At trial, a jury found that the defendant-agent was liable or misrepresentation, but also found that the plaintiff, Ms. Florenzano, was 62.5 percent negligent. The issues on appeal were (1) whether the comparative fault doctrine should apply to claims for negligent misrepresentation, and (2) whether the claim proven at trial was one for negligent misrepresentation or intentional misrepresentation. The Minnesota Supreme Court reversed the Court of Appeals and held that the facts supported only a finding of negligent misrepresentation, and that the claim was subject to the comparative fault doctrine, meaning that Ms. Florenzano recovered nothing. In so holding, the Florenzano court reaffirmed its adoption of the Restatement (Second) of Torts definition of negligent misrepresentation.
In Caritas, plaintiffs adopted a child from Caritas Family Services. The agency had informed the plaintiff-parents that there was a “possibility of incest in the family.” The parents responded “Well, it’s a baby. We’re happy. As long as it’s in the family it didn’t affect him.” A Caritas worker also warned them that the baby may have abnormalities related to the incest in his “background.” The plaintiffs testified that throughout the baby’s childhood he had serious emotional and behavioral problems, violent tendencies, and had been diagnosed with attention deficit disorder. When the boy’s psychologist requested more information regarding his genetic background, Caritas revealed that the boy’s parents were a 17-year-old boy and his 13-year-old sister. The father was “borderline hyperactive,” and had been seen at the local mental health center but discharged due to his refusal to cooperate with the therapist. The plaintiffs sued Caritas for negligently failing to disclose information about the genetic history of the child’s parents. The Minnesota Supreme Court held that after the agency had disclosed genetic information about the child’s biological parents, it owed a duty to the adoptive parents not to negligently withhold information in such a way as to mislead the adoptive parents. Caritas, 488 N.W.2d at 288. The intentional misrepresentation claim was defeated, however, because the Court concluded that the facts that were provided by Caritas were true, and that if it had meant to lie it would have never mentioned the baby’s incestuous background in the first place. Id. at 289.
Intentional vs Negligent Misrepresentation
The distinction between intentional misrepresentation and negligent misrepresentation may be critical to the viability of a plaintiff’s claim. If the representor did not have a duty to provide complete and timely information, or provides a waiver, a negligence claim may not survive where an intentional claim would. See e.g. Dakota Bank v. Eiesland, 645 N.W.2d 177, 181 (Minn. Ct. App. 2002). On the other hand, if intent to deceive cannot be shown, a negligence claim is often an easier alternative. See Caritas, 488 N.W.2d 282. The choice of claim can also affect the type of damages available under the economic loss doctrine as well as the comparative fault doctrine. See Florenzano, 387 N.W.2d 168.
In his concurring opinion in Florenzano, Justice Simonett set forth a third type of fraud claim – “reckless misrepresentation” – which he defined as “when the representor asserts a fact as of his own knowledge without knowing whether it is true or false.” Florenzano, 387 N.W.2d at 25, n. 2. Three years later, the Court of Appeals discussed the claim in Schule v. Meschke but declined to formally recognize it. Schule v. Meschke, 435 N.W.2d 156 (Minn. Ct. App. 1989). However, since then the claim as been recognized implicitly in several more cases. See Zutz v. Case Corp, 422 F.3d 764, 770 (8th Cir. 2005) (concluding the Minnesota District Court “correctly determined the tort of reckless misrepresentation exists in Minnesota”). Finally, it should be noted that the Minnesota Economic Loss Statute, Minn. Stat.§ 604.101, as amended by the Legislature in 2001, specifically refers to “reckless misrepresentation.”
Misrepresentation by Omission
There are four elements of fraudulent nondisclosure, also known as misrepresentation by omission: (1) a party conceals a material fact; (2) the fact is within the concealing party’s knowledge: (3) the concealing party knows that the acting party will rely on this nondisclosure on the presumption that the fact does not exist; and (4) the concealing party has a legal/equitable duty to communicate the fact. Richfield Bank & Trust Co. v. Sjorgren, 244 N.W.2d 648, 650 (Minn. 1976). See also Cold Spring Granite Company noting that, “Fraud may also be established by concealment of the truth.” citing Estate of Jones v. Kvamme, 449 N.W.2d 428, 431 (Minn. 1983).
The fourth element, the duty to communicate (also called a duty of disclosure), has been divided by some courts into three subcategories. Under this approach, courts have found a duty to exist:
- When a confidential or fiduciary duty relationship exists
- When disclosure is necessary to clarify misleading information already disclosed; or
- When one party has “special knowledge” of material facts to which the other party does not have access.
Id. See also Klein v. First Edina Nat’l Bank, 196 N.W.2d 619, 622 (1972).
Before a claim based on misrepresentation by omission can be made, there must exist a duty to disclose the omitted fact to the plaintiff. Richfield Bank & Trust Co., 244 N.W.2d at 648. As a general rule, one party to a transaction has no duty to disclose material facts to the other. Even parties within close relationships are not required to disclose everything to each other. Piekarski v. Home Owners Sav. Bank, F.S.B., 956 F.2d 1484 (8th Cir. 1992); see also Stowman v. Carlson Co., 430 N.W.2d 490, 493 (Minn. Ct. App. 1988).
A duty of disclosure most often arises in the arena of commercial transactions, but Minnesota courts have established a duty of disclosure in other contexts as well, such as where someone has herpes. R.A.P. v. B.J.P., 428 N.W.2d 10 (Minn. Ct. App. 1988) (fraud claims may be based on fraudulently induced personal injuries, where respondent’s failure to disclose that she had herpes is a misrepresentation because she had a legal duty to disclose it to her partner). Courts are generally more willing to find a duty where the non-disclosing party has superior knowledge and the other party is inexperienced and vulnerable. Jacobs v. Farmland Mutual Ins., 377 N.W.2d 441 (Minn. 1985) (Insurance adjuster knew plaintiff’s wrongful death claim was worth $15,000 but offered $4,000 due to his knowledge of plaintiff’s simplicity and inexperience).
The issue often arises as to where the line should be drawn limiting liability if a misrepresentation is communicated to parties other than those reasonably anticipated to rely on its contents. An accountant’s duty, for example, may extend beyond that of the client when the accountant is aware that other parties will rely on the work product. Bonhiver v. Graf, 248 N.W.2d 291 (Minn. 1976). The Restatement of Torts limits liability to the loss “suffered by a person or one of the persons for whose benefit and guidance [the person] intends to supply the information, or knows that the recipient intends to supply it.”
A variety of defenses are available to counter common law fraud claims. Prominent among these is a failure to plead with particularity. Pursuant to both Rule 9.02 of the Minnesota Rules of Civil Procedure and Rule 9 of the Federal Rules of Civil Procedure, “the circumstances constituting fraud… shall be stated with particularity.” Each element can become the focus of a legal battle, therefore, as the defendant need only knock out a single element or show that the fraud is not pled with sufficient detail in order to defeat the claim.
The “specificity” requirement of the Rules provides a useful weapon for defendants in fraud claims. The requirement has been justified as necessary to “safeguard” potential defendants from “lightly made claims charging the commission of acts that involve some degree of moral turpitude,” although others have opined that the “costs of requiring particularized pleading of fraud [may] outweigh the benefits.” 5 Charles Alan Wright & Arthur R. Miller, Treatise on Federal Practice and Procedure § 1296, at 577-81.
The reference in Rule 9 to “circumstances” is to “matters such as the time, place, and contents of the false representations, as well as the identity of the person making the misrepresentation and what he obtained thereby.” Id. at 590. Courts generally allow plaintiffs to amend deficient pleadings under Rule 15. Id. at 661. n.1. C.f. Martens v. 3M, 616 N.W.2d 732, 747 (Minn. 2000). But where a proposed amended complaint merely recites the generic elements of fraud, it may properly be denied. Schumaker v. Schumaker, 627 N.W.2d 725 (Minn. Ct. App. 2001).
Defenses based on the statute of limitations or the economic loss doctrine may also be germane. The statute of limitations on fraud claims in Minnesota is generally six years from the time the fraud was discovered pursuant to Minn. Stat. § 541.05, Subd. 1(6). A negligent misrepresentation claim based on a contract for the sale of goods or services may be barred or limited by the economic loss doctrine, Minn. Stat. § 604.101, Subd. 4 (2001). Intentional or “reckless” misrepresentations are not barred.
Determining damages claims in fraud actions can be nettlesome. Nationally, there are two distinct methods for calculating the damages that arise in a fraud claim: (1) the “out-of-pocket” rule; and (2) the “benefit-of-the-bargain” rule. See Am. Jur. 2d Fraud and Deceit § 384. Minnesota is generally considered to follow the “out-of-pocket” rule. Lewis v. Citizens Agency of Madelia, Inc., 235 N.W.2d 831, 835 (Minn. 1975). However, there are important exceptions to this rule, which may allow a plaintiff to recover greater damage awards under the “benefit-of-the-bargain” rule.
In Minnesota, the victim in a fraud action is entitled to damages equivalent to the victim’s “out-of-pocket” loss, that is “the difference between the actual value of the property received and the price paid for the property, along with any special damages naturally and proximately caused by the fraud prior to its discovery, including expenses incurred in mitigating the damages.” B.F. Goodrich Co. v. Mesabi Tire Co., Inc., 430 N.W.2d 180, 182 (Minn. 1988). See also, Popp Telcom v. American Sharecom, Inc., 210 F.3d 928, 936 (8th Cir. 2000) (noting that “Minnesota follows the out-of-pocket rule” but that “Minnesota courts have taken a broad approach to the concept of out-of-pocket damages” and that “there are situations where an unyielding application of the out-of-pocket rule fails to fully compensate victims of fraud.”).
Minnesota courts have refrained from adopting the “benefit-of-the-bargain” rule, which would allow the plaintiff to recover the difference between the value of the property received and the value to the plaintiff that the property would have had if the representation had been true. This method of calculation is attractive to plaintiffs because, in addition to out-of-pocket expenses, it allows for the recovery of lost profits tat would have been realized absent the defendant’s fraudulent representations. Although Minnesota does not generally recognize this approach, the courts do acknowledge there are situations in which “a party cannot be placed back in the status quo position by the out-of-pocket rule.” Lewis, 235 N.W.2d at 835. In these situations, the court will recognize an exception to the out-of-pocket rule and allow for recover under the benefit-of-the-bargain rule. See Brooks v. Doherty, Rumble & Butler, 481 N.W.2d 120, 128-29 (Minn. Ct. App. 1992) (noting Minnesota courts recognize “exception[s] to the out-of-pocket rule in order to restore the plaintiff to his former status in life”).
As Justice Wahl noted in Florenzano, fraud is a “protean legal concept, assuming many shapes and forms.” Common law fraud is flexible enough to be applied to many different situations, but it is subject to a wide variety of attacks as well under its multipart test and the strictures of Rule 9. Practitioners should therefore be prepared to confront these issues in advance.
About the author
V. John Ella is a Minnesota litigation and fraud attorney. He has handled many common law and statutory fraud claims for both plaintiffs and defendants and has presented seminars and written book chapters on common law fraud in Minnesota. Mr. Ella can be reached at 612-455-6237 or firstname.lastname@example.org.